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Chapter 13: Q. 3 (page 296)

Explain how time lags in discretionary fiscal policy making could thwart the efforts of Congress and the president to stabilize real GDP in the face of an economic downturn. Is it possible that these time lags could actually cause the discretionary fiscal policy to destabilize real GDP?

Short Answer

Expert verified

As a result, policymakers may push real GDP higher than anticipated, causing real GDP to become less stable.

Step by step solution

01

Introduction 

The given is the discretionary fiscal policymaking in the face of an economic downturn

The objective is to determine is it possible for this policy to destabilize real GDP

02

Explanation 

The president's and Congress's efforts to stabilize real GDP in the midst of an economic crisis could be thwarted by time lags in discretionary fiscal decisions.

The reason for this is that precise time recognition and information collecting are required in order to implement fiscal policy. As a result, the delay in acquiring information may cause the congress and the president to delay taking fiscal action.

As you may be aware, policy acts take time to manifest their full economic impact. As a result, if these time lags are very long, the likelihood of a downturn showing its effects by the time fiscal action is enacted increases.

As a result, authorities may push real GDP higher than intended in order to destabilize real GDP.

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Most popular questions from this chapter

List and define fiscal policy time lags and explain why they complicate efforts to engage in fiscal "fine tuning".

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (a) of Figure 13-1, the government determined that the amount by which the AD curve had to be shifted directly rightward from the point E1 was equal to \(1.0 trillion. If the government decided that a \)0.2 trillion increase in real government spending was required to generate this shift, what must be the value of the MPC?

Recall that the Keynesian spending multiplier equals 1 /(1-M P C). Suppose that in Figure 13-4, the MPC is equal to 0.9. In addition, the amount of the horizontal leftward shift from AD2 to AD3 caused by a crowding-out effect on planned investment spending was 0.5\( trillion, or \) 500 billion. How much investment spending was crowded out?

Suppose that Congress and the president decide that the nation's economic performance is weakening and that the government should "do something" about the situation. They make no tax changes but do enact new laws increasing government spending on a variety of programs.

a. Prior to the congressional and presidential action, careful studies by government economists indicated that the Keynesian multiplier effect of a rise in government expenditures on equilibrium real GDP per year is equal to 3. In the 12 months since the increase in government spending, however, it has become clear that the actual ultimate effect on real GDP will be less than half of that amount. What factors might account for this?

b. Another year and a half elapses following passage of the government spending boost. The government has undertaken no additional policy actions, nor have there been any other events of significance. Nevertheless, by the end of the second year, real GDP has returned to its original level, and the price level has increased sharply, Provide a possible explanation for this outcome.

It is late 2019 , and the U.S. economy is showing signs of slipping into a potentially deep recession. Government policymakers are searching for income-tax-policy changes that will bring about a significant and lasting boost to real consumption spending. According to the logic of the permanent income hypothesis, should the proposed income-tax-policy changes involve tax increases or tax reductions, and should the policy changes be short-lived or long-lasting?
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